Legal Spotlight

Insured-Vs.-Insured Exclusion Cited in Dismissal

Cheryl Sullivan became a member of the JEI board of directors in April 2013, upon the death of her father, Jerry Paulson, who had expanded a small butcher shop into JEI, a retail and grocery store chain in Minnesota, Wisconsin and Florida. Sullivan redeemed her 28 percent of all company shares a few months later, after which she and her daughters sued the company, saying that JEI’s directors “designed to lower the value of their shares.”

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Sullivan and her daughters reached a confidential settlement with JEI. The company sought coverage for the payment under a directors and officers policy issued by U.S. Specialty Insurance Co.

The insurer rejected the claim and JEI filed suit. After the U.S. District Court for the District of Minnesota ruled against JEI, it appealed to the U.S. 8th Circuit Court of Appeals.

On Jan. 11, the appeals court agreed with U.S. Specialty. The two main issues related to the policy’s insured-versus-insured exclusion and its allocation clause. The insured-versus-insured exclusion barred coverage for any suit brought by a former director of the company.

But Sullivan’s daughters were not former directors, and the allocation clause provided that losses should be allocated between covered and uncovered claims. The appeals court ruled that Sullivan was “an active participant” in the lawsuit as well as its “driving force.” Because of that, the policy’s allocation provision for coverage as long as a director or officer “did not solicit, assist or actively participate in the lawsuit” did not apply to Sullivan or her daughters.

Scorecard: The insurance company does not need to indemnify JEI for the settlement payment.

Takeaway: The allocation clause “does not restore coverage for a suit brought with the active participation of an insured person,” the court ruled.

Bird Flu Transmission is Crucial to Case

Farms in minnesota from eight to 20 miles away from rembrandt Enterprises’ egg-producing facilities euthanized their chickens due to avian bird flu in 2015. In April and May of that year, Rembrandt’s flock was infected and a month later, more than 9 million birds were euthanized.

Rembrandt filed a claim with Illinois Union Insurance Co., which had issued a premises pollution liability insurance policy. The policy insured Rembrandt’s farms from the “discharge, dispersal, release, escape, migration or seepage of any … irritant, contaminant, or pollutant … on, in, into, or upon [covered] land and structures.”

The carrier denied the claim, saying the flu was not a contaminant and that coverage excluded losses relating to “naturally occurring materials” unless they were present because of human activities. Illinois Union Insurance later conceded the flu was a contaminant, but said there was no proof that human activities led to the bird flu being transmitted to Rembrandt’s farms. Rembrandt filed suit, claiming the carrier breached its policy. The carrier sought to dismiss the case.

An infectious diseases expert on behalf of Rembrandt said the bird flu was “detected in air samples taken inside and outside infected poultry houses,” and that the flock depopulations at nearby farms created a “virus cloud” that carried the flu to Rembrandt’s farms.

On Jan. 12, the U.S. District Court for the District of Minnesota refused to dismiss the case, ruling further hearings were needed.

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“Despite extensive briefing, on this record, the Court is simply not in a position to determine as a matter of law how the bird flu spread to Rembrandt’s farms and, accordingly, neither party is entitled to summary judgment,” the court ruled.

Scorecard: No decision was issued on whether the farms will collect for the loss of more than 9 million birds.

Takeaway: While the disease may be spread by air, it is not clear whether it was aided by human activity.

Court: Policy Excludes $64 Million Claim

Imprudent loans, resulting in more than $64 million in losses, caused the California Department of Financial Institutions to close Security Pacific Bank.

The Federal Deposit Insurance Corp. (FDIC), which was named receiver, filed suit against BancInsure Inc., seeking coverage for losses “arising from the negligence, gross negligence and breach of fiduciary duty allegedly committed by” the failed bank’s former directors and officers.

The U.S. District Court for the Central District of California concluded that the D&O policy issued by BancInsure covered the FDIC’s claims. The U.S. 9th Circuit Court of Appeals reversed that decision on Jan. 10.

The D&O policy excluded coverage for losses arising from legal actions brought by “any successor, trustee, assignee or receiver” of the bank. The FDIC argued that it is “not a ‘receiver’ within the meaning of the insured-versus-insured exclusion because, by statute, it has a ‘unique role’ representing ‘multiple interests,’ ”including shareholders and depositors. It pointed to an exception to the exclusion for “a shareholder’s derivative action,” which could be filed against the failed bank by shareholders who are not insureds under the D&O policy.

The appeals court rejected that argument. “We think the term ‘receiver’ is clear and unambiguous and includes the FDIC in its role as receiver of Security Pacific,” it ruled, ordering the lower court to dismiss the case.

Scorecard: The FDIC will not be able to collect more than $64 million in losses from BancInsure.

Takeaway: The right of the FDIC to bring a shareholder derivative action was secondary to the FDIC’s right to bring the same claims directly as the failed bank’s receiver.

Anne Freedman is managing editor of Risk & Insurance. She can be reached at [email protected]

Ask the average citizen what they think about the future of U.S. manufacturing, and you’re likely to hear bleak projections of companies shipping their operations offshore, or robots displacing human workers. Overall, the industry’s public image is fading at the edges — people perceive waning relevance and opportunity.

“But if you ask manufacturers what they think, the response is the exact opposite. U.S. manufacturers are actually quite enthused about the future,” said Seth Hedrington, Senior Vice President and General manager, National Insurance, West Division, Liberty Mutual Insurance. “It’s a very dynamic industry with new opportunities every day.”

Advancements in technology are changing the game in terms of capabilities, efficiency and agility.

“Automation and robotics enable smaller entities to produce at a smaller scale, which puts pressure on every player to become more efficient,” Hedrington said. But additional, less publicized

technology is also making a big impact. The Internet of Things, blockchain, and 3D printing, to name a few, are lowering barriers to entry and enabling companies to move into new markets more quickly.

Seth Hedrington, Senior Vice President and General Manager, National Insurance, West Division, Liberty Mutual Insurance

Thanks to these developments, technology is driving competition. However, its benefits are simultaneously counteracted by the challenge of keeping up with rapidly-changing consumer preferences, government regulation, and an ongoing labor shortage.

The result is an environment teeming with both opportunity and obstacles. “Manufacturers have to make changes to stay in the game, but that introduces new risks,” Hedrington said.

Here are five ways manufacturers are reacting to a newly competitive environment that may expose them to unforeseen risks:

1. Stretching an existing workforce to combat a shortage of qualified workers.

The inability to attract and retain workers remains a top challenge for manufacturers, in part because the nature of the skill set required is changing rapidly. Because technology plays such a significant role in front-line production processes, manufacturers need people who not only operate the machines, but also understand how they work.

“They need workers who are more adept with technology, and that’s harder to come by,” Hedrington said.

To increase capacity, companies are lengthening or adding shifts for their existing workforce, which increases the likelihood of fatigue and the risk of injury. While co-bots may reduce labor demands and mitigate safety risk over the long term, they too present short-term challenges.

“Introducing new machinery or even new workers creates unfamiliarity, and that initially increases safety risk,” Hedrington said.

These changes also have product liability implications. “When you extend shifts, you’re taxing the equipment as well as your workers,” Hedrington said. “That makes it more difficult to achieve a consistent level of product quality.”

Thanks to recent tariffs on key imports like aluminum and steel, raw materials are becoming more expensive. “Manufacturers are faced with some of the most extreme fluctuations in the cost of materials that we’ve seen in recent history,” Hedrington said.

To control costs, some companies are turning to suppliers from regions not impacted by the tariffs. But significant risks always accompany a change in trade relationships. Product defect liability is chief among them, but the risk of supply chain interruption is also an issue.

“If you’re working with alternate suppliers and relationships are not as established, the risk of interruption is greater,” Hedrington said. Failure to deliver products on time ultimately presents a reputational risk and threatens a manufacturer’s ability to keep their contracts.

Risk Management Steps:

Maintain relationships with previous suppliers.

Develop contingency plans and a network of backup suppliers.

Review contract language addressing liability for faulty materials.

3. Diversifying operations to become more nimble and fast-paced.

Technology makes it easier to stay connected anywhere in the world, and more manufacturers are taking advantage of that to open multiple locations across the U.S. and abroad.

“As companies start to feel pressured by the competitive environment, they’ll look for opportunities to manufacture in other parts of the world where regulatory hurdles and costs are smaller,” Hedrington said.

That, however, may increase exposure to intellectual property (IP) theft. While cyber breach happens everywhere, an international supply chain typically means a more expansive network, so the potential for infiltration and IP theft is greater. The ability to seek damages for IP theft occurring outside the U.S. can also be more challenging.

“A global network is a lot more difficult to manage—you need to regularly evaluate who has access, what they have access to, and make sure the access is secure,” Hedrington said. Limiting access to confidential information to specific groups or a specific location, like a U.S. headquarters, could help mitigate the exposure.

Risk Management Steps:

Add language to contracts that protect proprietary and IP rights.

Limit research and development to company headquarters.

Review internal IT protections.

4. Making facilities “smarter” to improve production and output.

More manufacturers are incorporating sensors and internet-enabled technology that allows machines to collect and share data and work together in an automated fashion. This ‘smart’ technology provides valuable insights into the efficiency of production processes.

“The risk associated with “smart” machinery is their interconnectivity,” Hedrington said. “Anytime you have that level of connectivity, you have an increased level of risk to cyber breach.” It’s also easier to make unintentional or unauthorized changes to product design and specifications or material thresholds, which could impact product quality and safety.

“Many manufacturers don’t perceive themselves as major targets for cyber-attack, but failing to appreciate and mitigate that exposure can result in significant losses. In addition to reviewing your internal IT safeguards, it’s critical to review your insurance options. If you’re not considering the benefits of insurance, that’s a significant missed opportunity to protect your business,” he said.

Risk Management Steps:

Update your cyber policy to include both first- and third-party coverage.

Manufacturers in a variety of consumer product segments, from razors and eyeglasses to mattresses and sneakers, are increasingly exploring direct to consumer models that cut out the middle man. While few manufacturers are abandoning their traditional distribution outlets all together, they are considering e-commerce and even brick-and mortar locations of their own.

In addition to increased efficiencies, this format allows manufacturers more control over the customer experience and a bigger share of the profits.

“Going direct-to-consumer is another way to beat out competitors,” Hedrington said. “Technology and the connectivity of everything has helped open up new distribution avenues.”

It also, however, confers liabilities to the manufacturer that the middle-men normally accept, such as product and safety liability for proper packaging and labeling, as well as other operational risks that come with running a storefront, including workers’ compensation, cyber, property and general liability exposures.

Risk Management Steps:

Don’t completely shut down traditional distribution channels.

Ensure you have the skills to manage operational risks of direct distribution.

Build a cross-functional team to build a thorough risk management plan.

Your Insurer’s Experience and Expertise Matter

Manufacturing represents one of the largest business segments that Liberty Mutual serves, and teams across the organization have specialized expertise in the unique challenges facing this evolving sector.

Liberty insures a wide variety of manufacturers, wants to write more, and has the products to address the industry’s specific exposures. The company can offer a holistic solution that includes core property & casualty, as well as cyber, D&O, and environmental lines through Ironshore, a Liberty Mutual company.

“Liberty Mutual is entrenched in the risk management practices of the manufacturing industry. Our risk control professionals participate in many boards and committees that create standards to improve equipment, product, and employee safety. Additionally, our Industry Solutions and Product Management teams have a deep understanding of the manufacturing industry and help customers stay ahead of emerging risks,” Hedrington said.

In addition, Liberty’s claims handlers have the experience, capabilities, and knowledge to deliver quality outcomes so manufacturers can rebound from losses as quickly as possible.

“Our commitment to this space manifests itself in many ways, and that will hold true as U.S. manufacturing continues to evolve,” Hedrington said.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty Mutual Insurance. The editorial staff of Risk & Insurance had no role in its preparation.

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